Revsine FRA 8e Chap011 SM

Financial Reporting and Analysis (8th Ed.
)
Chapter 11 Solutions
Long-Lived Assets and Depreciation
Exercises
Exercises
E11-1. Capitalizing costs (LO 11-2)
Phoenix may capitalize the following costs to the Machine account:

Finder’s fee $ 2,000
List price 230,000
Transportation fee 4,000
Installation fee 2,500
Total cost to capitalize $238,500
The finder’s fee, list price, transportation fee and installation fee are all
necessary to get the asset (machinery) into place and position for its intended
use and are therefore capitalized costs.
The speeding ticket and the damage repair are expensed as incurred since
they are not ordinary and necessary costs to acquire and make the machinery
ready for use.
E11-2. Determining depreciation expense—multiple methods (LO 11-7)

Requirement 1:
($315,000 − $15,000) ÷ 10 years = $30,000
Requirement 2:
($315,000 − $15,000) ÷ 15,000 units = $20/unit
1,200 units x $20 = $24,000
Requirement 3:
($315,000 − $15,000) ÷ 20,000 hours = $15/hour
2,100 hours x $15 = $31,500
Requirement 4:
Denominator = 10 x (10 + 1) ÷ 2 = 55
($315,000 − $15,000) x 10/55 = $54,545
Requirement 5:
$315,000 x (10% x 2) = $63,000
11-1
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Education.
E11-3. Capitalizing costs subsequent to acquisition (LO 11-2)
Requirement 1:
The following costs are capitalized to the building:
Major improvement to the plumbing $109,000

Added a 7,000 square foot lobby 234,600
Total $343,600
GAAP requires a company to capitalize expenditures that extend an asset’s

useful life, increase its capacity or efficiency, or cause any other increase in its
economic benefits. A major plumbing improvement and a building addition meet
these criteria and are capitalized costs.
The painting, carpet, and repair costs are expensed since they do not improve
efficiency or extend the productive life of the building.
Requirement 2:
New carrying value of the building:
Historical cost $970,000

Add: Improvements 343,600
Less: Accumulated depreciation (440,000)
New carrying value $873,600
11-2
Education.
E11-4. Determining depreciation expense – multiple methods (LO 11-7)
Requirement 1:
($125,000 − $5,000) ÷ 6 years = $20,000
20X1: $20,000 x ¾ year = $15,000
2018: $20,000
Requirement 2:
($125,000 − $5,000) ÷ 25,000 units = $4.80/unit
20X1: $4.80 x 3,000 units = $14,400
2018: $4.80 x 4,200 units = $20,160
Requirement 3:
Rate = (1/6) x 2 = 1/3
20X1: $125,000 x 1/3 x 3/4 = $31,250
2018: ($125,000 − $31,250) x 1/3 = $31,250
Requirement 4:
Denominator = 6 x (6 + 1) ÷ 2 = 21
20X1: ($125,000 − $5,000) x 6/21 x 3/4 year = $25,714
2018: ($125,000 − $5,000) x 6/21 x 1/4 year = $8,571
($125,000 − $5,000) x 5/21 x 3/4 year = $21,429
$30,000
E11-5. Determining depreciation base – straight-line depreciation (LO 11-2, LO

11-7) (AICPA adapted)
First determine the book value of the machine at the beginning of 20X1. Given
that the machine has been used for 10 years and has a 20 year life,
Accumulated depreciation would be $15,000 (10/20 x $30,000). The book value
at January 1, 20X1 also is $15,000 ($30,000 cost less $15,000 accumulated
depreciation).
The $5,000 overhaul increases the value of the machine by $5,000, so the new
book value is $20,000 ($15,000 + $5,000). The overhaul added 5 years onto
the life of the machine, so the remaining useful life of the machine at January 1,
20X1 is 15 years (10 years + 5 years). To find the depreciation expense for
20X1, take the new book value ($20,000) divided by the remaining useful life of
the machine (15 years).
$20,000/15 years = $1,333
Depreciation expense for 20X1 is $1,333.
11-3
Education.
E11-6. Exchanging assets (LO 11-9)
Entry by Williamsport Crosscutters:
DR Player contract—Ruiz $ 1,000,000
CR Player contract—Clemens $500,000
CR Gain $500,000
Entry by Reading Phillies:

DR Player contract—Clemens $ 1,000,000
CR Player contract—Ruiz $800,000
CR Gain $200,000
E11-7. Determining asset cost and depreciation expense – straight-line (LO 11-2,
LO 11-7) (AICPA adapted)
First, we must find the total cost of the machine.
Purchase price $65,000

Freight-in 500
Installation 2,000
Testing 300
Total cost of machinery $67,800
Less: salvage value (5,000)
Depreciation base $62,800
Now we can find depreciation expense for 20X0 and 20X1:

$62,800/20 years = $3,140
Next, we need to determine the depreciation base of the machine in January

20X2. The machine has been depreciated for two years, so:
Depreciation base, January 1, 20X0 $62,800

20X0 depreciation (3,140)
20X1 depreciation (3,140)
Depreciation base at January 1, 20X2 $56,520
The accessories add $3,600 to the machine’s value, so the depreciation base at
January 1, 20X2 is: [$56,520 + $3,600 = $60,120].
The accessories did not add useful life or more salvage value. The remaining
useful life of the machine is 18 years (20 - 2). To find straight-line depreciation
expense, we divide the depreciation base by the remaining useful life.
$60,120/18 years = $3,340
Samson should record $3,340 as depreciation expense for 20X2.
11-4
Education.
E11-8. Buying assets with a note (LO 11-2)
The plant assets should be recorded at the discounted present value of the
payments:
Discount Factor Discounted Present
Payment date Amount at 10% Value
January 1, 20X1 $10,0001.00000 $10,000.00
January 1, 20X2 10,000.90909 9,090.90
January 1, 20X3 10,000.82645 8,264.50
January 1, 20X4 10,000.75132 7,513.20
January 1, 20X5 10,000.68301 6,830.10
Total $41,698.70
DR Plant assets $41,698.70

CR Cash $10,000.00
CR Contract payable 31,698.70
E11-9. Determining retirement obligation (LO 11-6)

(AICPA adapted)
Purchase price of land $20,000,000

Asset retirement obligation ($6,000,000 x .76290)
(.76290 is the present value of $1, n = 4, i = 7%) 4,577,400
Book value of mine $24,577,400
Depletion rate = (book value – salvage value) ÷ recoverable units

Depletion rate = ($24,577,400 − $1,000,000) ÷ 4 million tons = $5.89*/ton
* = rounded
E11-10. Capitalizing interest (LO 11-2)

(AICPA adapted)
The avoidable interest during 20X1 is:
Cost incurred evenly over the year $2,000,000

 x .50
Average cost during the year $1,000,000
Incremental borrowing rate x .12
Avoidable interest $ 120,000
Since the actual interest incurred ($102,000) was lower than avoidable
interest, Clay should report $102,000 as capitalized interest at December 31,
20X1.
11-5
Education.
E11-11. Capitalizing interest (LO 11-2)
(AICPA adapted)
Requirement 1:
The interest on weighted average accumulated expenditures is the amount of
avoidable interest. Since the avoidable interest ($60,000) is less than the
interest actually accrued ($85,000), only the avoidable interest is capitalized.
The journal entry to record this transaction follows.
DR Building (capitalized interest) $60,000

DR Interest expense $25,000
CR Cash $85,000
Requirement 2:
The interest on weighted average accumulated expenditures is the amount of
avoidable interest. Since the avoidable interest ($90,000) is more than the
actual interest ($85,000), only the actual interest is capitalized (i.e., interest
that is not actually incurred cannot be capitalized).
E11-12. Analyzing changes in asset account balances – straight-line (LO 11-3,

LO 11-7) (AICPA adapted)
To determine the amount debited in 20X1, we reconstruct the accumulated

depreciation T-account:
Accumulated Depreciation
$370,000Beginning balance (1/1/08)
55,000
Depreciation expense
Accumulated depreciation from
retirement of PP&E X
$400,000
Ending balance
$370,000 + $55,000 - X = $400,000

X = $25,000
Weir must have debited $25,000 to accumulated depreciation during 20X1

because of property, plant, and equipment retirements.
11-6
Education.
E11-13. Identifying depreciation expense patterns – SL, DDB, and SYD (LO 11-7)
(AICPA adapted)
Line II corresponds to the sum-of-the-years’-digits method, and Line III

corresponds to the double-declining balance method. Sum-of-the-years’ digits
is a linear pattern, while double-declining balance is more accelerated and
non-linear.
E11-14. Amortizing intangibles (LO 11-4)

(AICPA adapted)
First, determine the book value of the trademark at 1/1/20X4:
December 31, 20X0 20X1 20X2 20X3

Amortization amount
($400,000/16) $25,000 $25,000 $25,000 $25,000
Book value $375,000 $350,000 $325,000 $300,000
The italicized number represents the book value of the asset at December 31,
20X3 (or January 1, 20X4). The legal fees paid add $60,000 to the cost of the
trademark that also must be amortized. The book value of the trademark at
January 1, 20X4 is:
$300,000 + $60,000 = $360,000
The trademark has been amortized for four years so it has 12 years of
remaining useful life (16 - 4 = 12). To find amortization expense for 20X4,
divide the book value of the trademark by the remaining useful life.
$360,000/12 years = $30,000
Vick would record $30,000 of trademark amortization expense for the year
ended December 31, 20X4.
11-7
Education.
E11-15. Amortizing intangibles (LO 11-4)
Find the book value of the patent at 12/31/20X4. The patent is amortized over
its useful life (10 yrs.) instead of its valid legal life (15 yrs.) because the useful
life is shorter.
December 31, 20X1 20X2 20X3 20X4

Amortization amount
($90,000/10 years) $9,000 $9,000 $9,000 $9,000
Book value of patent $81,000 $72,000 $63,000 $54,000
On December 31, 20X4 the patent has a book value of $54,000. If the product
is permanently withdrawn from the market, then the patent becomes
worthless. Lava would incur a loss on impairment for the entire book value of
the patent, $54,000. The journal entry to record this impairment is:
DR Loss on impairment $54,000

CR Patent $54,000
The total charge to income in 20X4 is $63,000, i.e., $54,000 + $9,000.
E11-16. Accounting for R&D cost (LO 11-4)
All of the costs should be expensed as research and development for 20X1.
R&D services performed by Key Corp. $150,000

Design, construction, testing 200,000
Testing for new product/process alternatives 175,000
Total research & development expense $525,000
E11-17. Accounting for R&D cost (LO 11-4)
Costs incurred in Ball Labs that will not be reimbursed by the governmental
unit should be expensed as research and development. The computation
follows:
Depreciation $300,000
Salaries 700,000
Indirect costs 200,000
Materials 180,000
Total $1,380,000
Ball should expense $1,380,000 as research and development for 20X1.
E11-18. Accounting for software development costs (LO 11-4)

11-8
Education.
Requirement 1:
All costs incurred during 20X0 are expensed as part of research and
development (R&D) expense in 20X0. Until technological feasibility is
achieved, all costs associated with software development are expensed as
incurred.
Requirement 2:
During 20X1, Pearl should expense one-half of the costs as R&D and should
capitalize the remaining one-half of the costs as “Capitalized Computer
Software Costs” in accordance with (FASB ASC 985-20-25-2: Software—
Costs of Software to Be Sold, Leased, or Marketed—Research and
Development Costs of Computer Software. This is different from the results in
requirement 1 because during 20X1, Pearl engineers determined that the
product was technologically feasible. GAAP requires companies to capitalize
computer software costs once this milestone has been reached.
E11-19. Determining depletion expense with asset retirement obligation – units-

of-production (LO 11-6, LO 11-7)
(AICPA adapted)
To determine the depletion base, we need to add together the costs

associated with the mine and subtract any salvage value.
Purchase price of mine $2,640,000

Development costs 360,000
Present value of restoration costs 180,000
Less: salvage value (300,000)
Depletion base $2,880,000
Next we need to find the depletion cost per unit, computed below:
Depletion base = $2,880,000 = $2.40 per unit

Total estimated units available 1,200,000
removed
Knowing the depletion cost per unit and the number of units (tons) removed,
we can solve for depletion expense:
60,000 tons of ore removed x $2.40 per ton = $144,000
Vorst should report $144,000 as depletion expense for 20X1.

11-9
Education.
E11-20. Accounting for Deferred Costs (LO 11-2)
Requirement 1:
The following costs would be capitalized:
One-time city work permit fee $ 4,500
Sales commissions 15,000
Total $ 19,500
The other costs would have been incurred regardless of

whether Ritz won the work. Therefore, they cannot be
capitalized
Requirement 2:
Total costs capitalized $ 19,500
Divide by expected years to complete 3
Annual amortization $ 6,500
Multiply by portion of first year 0.5
Amortization in 20X1 $ 3,250
Other costs:
Travel 2,000
Proposal development 10,000
Legal fees 3,000
Total $ 18,250
11-10
Education.
Financial Reporting and Analysis (8th Ed.)
Chapter 11 Solutions
Problems
Problems
P11-1. Computing depreciation expense – SL, DDB, SYD, and UP (LO 11-7)
(AICPA adapted)
The table below shows the amount of depreciation expense in 20X1 under each
method. Computations are shown below the schedule.
Straight-line
20X1 $90,000
Double-declining balance
20X1 $162,000
Sum-of-years’ digits
20X1 $140,000
Units of production
20X1 $120,000
Total cost − Salvage value =

Requirement 1 – Straight-line: Estimated useful life
$864,000 − $144,000
= $90,000 per year
8 years
Requirement 2 – Double-declining balance:

Depreciation in 20X0
Straight-line rate = 1/8 or 12.5%. Double this is 25%.
$864,000 x 25% = $216,000
[Book value = total cost - accumulated depreciation]
$648,000 = $864,000 - $216,000
$648,000 x 25% = $162,000
11-11
Education.
Requirement 3 – Sum-of-years’ digits: Depreciation in 2016
Year
x [Total cost - Salvage value]
Sum - of - years’ digits
8
= x [$864,000 - $144,000]
1+2+3+4+5+6+7+8
8
= x $720,000
36
= $160,000
7
= x $720,000
36
= $140,000
Requirement 4 – Units of production:
Total cost - Salvage value $ 864,000 - $ 144,000

=
Total estimated units producible 1,800,000 units
$720,000
=
1,800,000 units
= $0.40 per unit
Depreciation = depreciation cost per unit x number of units actually produced

= $0.40 per unit x 300,000 units = $120,000
11-12
Education.
P11-2. Recording lump-sum purchases (LO 11-2)
Requirement 1:
Cost of land and building:
Land:
FMV of land/FMV of land and building
$6,300,000/$17,500,000 = 36%
Cost of land = $15,000,000 x .36 = $5,400,000
Building:
FMV of building/FMV of land and building
$11,200,000/$17,500,000 = 64%
Cost of building = ($15,000,000 x .64) + cost of modifications to building
= $9,600,000 + 1,000,000
= $10,600,000
Requirement 2:
Depreciation is not recorded on land. Thus, the higher the amount assigned to
the land, the lower will be future years’ depreciation expense, and the higher
will be the net income of such years.
11-13
Education.
P11-3. Determining asset cost when purchased with a note (LO 11-2)
At a discount rate of 10%, the present value of the note is:
$400,000 x 1/(1 + 0.10)4
= $400,000 x 0.68301
= $273,204
Since this is more than the cash price of $250,000, Cayman should pay cash.
At a discount rate of 13%, the present value of the note is:
$400,000 x 1/(1 + 0.13)4
= $ 400,000 x 0.61332
= $245,328
In this case, since the present value of the note is less than the cash price of
$250,000, Cayman should issue the note to the seller rather than paying cash.
11-14
Education.
P11-4. Accounting for deferred costs (LO 11-2)
Requirement 1:
Finder's fee $ 7,500,000
Percent 2%
Total $ 150,000
The other costs would have been incurred regardless of whether

Hopkins won the work. Therefore, they cannot be capitalized
Requirement 2:
Total costs $ 150,000
Divide by expected years to complete 2

Annual amortization $ 75,000
$ 37,500
Other costs:
Legal fees 10,000
Proposal development 15,000
Total $ 62,500
11-15
Education.
Requirement 3:
July 1, 20X1
DR Legal expense $ 10,000
DR Salary expense 15,000
CR Cash $ 25,000
To record contract expenses
DR Deferred contract costs $ 150,000

CR Finder's fee payable $ 150,000
To accrue finder's fee
August 1, 20X1
DR Finder's fee payable $ 150,000
CR Cash $ 150,000
To pay finder's fee
December 31, 20X1

DR Contract expense $ 37,500
CR Deferred contract costs $ 37,500
To amortize contract costs
11-16
Education.
P11-5. Accounting for deferred costs (LO 11-2)
Requirement 1:
Installer labor ($30 x 2 workers x 4 hours) $ 240
Equipment and supplies 550
Total $ 790
The modems will be also be capitalized, but they will be classified as

property, plant, and equipment. The ongoing $15 monthly costs will be
expensed as incurred.
Requirement 2:
Total deferred incremental costs $ 790.00
Divide by expected years of contract 5.00
Annual amortization $ 158.00
$ 39.50
Other costs:
Modem depreciation
(.25 years x $150 cost/6 years) 6.25
Ongoing monthly costs (3 x $15) 45.00
Total $ 90.75
Requirement 3:
October 1, 20X1
DR Deferred contract costs $ 790
CR Salary expense $ 240
CR Supplies inventory 550
To defer costs of installation
October 31 to December 31, 20X1

DR Service expense $ 15
CR Cash, Accrued expense, Accumulated
_ depreciation, etc. $ 15
To accrue ongoing monthly service
December 31, 20X1

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Education.
DR Contract expense $ 39.50
CR Deferred contract costs $ 39.50
To amortize contract costs
DR Depreciation expense $ 6.25

CR Accumulated depreciation $ 6.25
To record modem depreciation expense
The December 31 entries may also be broken into monthly entries.
11-18
Education.
P11-6. Allocating acquisition costs among asset accounts and interest
capitalization (LO 11-2)
Relative assessed values of the land and building at the time of purchase:
Land: $105,000,000/$125,000,000 = 84%
Warehouse: $ 20,000,000/$125,000,000 = 16%
Purchase price of the land and buildings:
Cash $ 25,000,000
Note payable 5,000,000
Common stock 80,000,000
($80 x 1,000,000)
Legal fees 25,000
Total $110,025,000
Initial allocation of cost:
Land: $110,025,000 x 0.84 = $92,421,000
Warehouse: $110,025,000 x 0.16 = $17,604,000
Allocation of subsequent costs:
Land:
Initial allocated cost $92,421,000
Demolish old building 50,000
Grade land 250,000
Total cost assigned to the land account: $92,721,000
Warehouse:
Initial allocated cost $ 17,604,000
Renovate old building 25,000,000
Interest incurred during construction 2,000,000
Total cost assigned to the
Warehouse account: $44,604,000
11-19
Education.
Department store:
Cost of new building 100,000,000
Interest incurred during construction 8,000,000
Department store building: $108,000,000
Land improvements:
Asphalt parking lot $450,000
Lighting 200,000
Fencing and gate 75,000
land improvements account: $725,000
The $725,000 would be recorded in the land improvements account rather than
the land account because the parking lot, lighting, fencing and gate have a finite
useful life over which the $725,000 would be depreciated. Land, on the other
hand, has an infinite useful life and is not depreciated.
The training expenditures $150,000 would be charged against 20X1 income.
P11-7. Exchanging assets (LO 11-9)

Requirement 1:
Hoyle’s entry to record the exchange:
DR Warehouse (fair value) $ 4,400,000
DR Cash 200,000
DR Loss on exchange 250,000
DR Accumulated depreciation 3,650,000
CR Manufacturing plant $8,500,000
Requirement 2:
Patterson’s entry to record the exchange:
DR Manufacturing plant (fair value) $ 4,600,000
DR Accumulated depreciation 2,800,000
CR Warehouse $6,900,000
CR Cash 200,000
CR Gain 300,000
11-20
Education.
P11-8. Capitalizing or expensing various costs (LO 11-2)
Requirement 1:
1) Since the new engines increase the future service potential of the aircraft,
the amount should be capitalized and depreciated over the engines’ useful life.
2) Since there is no increase in useful life, future service potential, or efficiency,

the amount should be charged to expense in the current year. Some might
argue that this is a bit of a gray area. For example, if the campaign is
successful, future service potential might increase. On the other hand, the
expenditure is also a bit like advertising, which is a period expense.
3) Since the repairs are routine (i.e., recurring), the amount should be charged
to expense in the current year.
4) The noise abatement equipment is mandated and is, thus, an unavoidable,

necessary cost that allows the planes to use runways and airports that could
not be utilized otherwise. Therefore, this cost is capitalizable.
5) Since the new systems increase the future service potential of the aircraft,
the amount should be capitalized and depreciated over the now extended
useful life of the systems.
6) Again, some might argue that this is another gray area. Since the objective
of the expenditure is to increase business, it might warrant capitalization. On
the other hand, since there is no increase in useful life, future service potential,
or efficiency, the amount could be charged to expense in the current year.
7) Since the overhauls increase the efficiency of the engines, the amount
should be capitalized and depreciated over the expected useful life of the
improvements.
Requirement 2:
Perhaps the easiest way for a firm like Fly-by-Night to use some of the above
expenditures to manage earnings upward is to capitalize a portion of those that
might otherwise be treated as expenses of the period. Other ways Fly-by-Night
could manage earnings is to defer maintenance expenditures while keeping
them just above the minimum required by the Federal Aviation Administration.
Fly-by-Night might also consider “bunching” expenditures in a
given year to achieve a “big bath.” This would then improve future years’
earnings.
11-21
Education.
P11-9. Determining asset impairment (LO 11-5)
Requirement 1:
Book value:
= $35,000,000 - [($35,000,000/7) x 4]
= $35,000,000 - 20,000,000
= $15,000,000
Requirement 2:
Yes, the asset is impaired.
The book value of $15,000,000 is greater than the undiscounted future cash
flows of $11,000,000.
Impairment loss to be reported in the income statement:
= $15,000,000 - Fair value of the asset

= $15,000,000 - 9,500,000
= $5,500,000
Requirement 3:
The balance sheet amount at the end of year 4 is $9,500,000, the asset’s fair
value. Omega would depreciate this amount over the asset’s remaining useful
life.
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Education.
P11-10. Determining asset impairment (LO 11-5)
Requirement 1:
Assets should be tested for impairment whenever events or circumstances
indicate that the asset’s carrying value might be impaired. In this case, due to
the economic downturn and concerns among the yachting public related to Sick
Yacht Syndrome, Yachting in Paradise has information that its yacht may have
suffered an impairment of value.
Requirement 2:
The following impairment test indicates that Yachting in Paradise’s yacht is
impaired:
Book value:
= ($15,000,000 − $3,000,000) ÷ 15 = $800,000/year depreciation

= $800,000 x 6 years [20X1 through 20X6 inclusive] = $4.8 million
$15,000,000 − $4,800,000 = $10,200,000 book value in early 20X7.
Estimated annual future net cash flow $1,050,000

Remaining life of yacht (years) x9
Undiscounted future net cash flow $9,450,000
The equipment is impaired since its undiscounted net future cash flow is below
its carrying value.
An asset’s impairment is measured by reference to its fair value. (Note to

instructor: The present value of the annual cash flows = $6,600,000. This
amount is only relevant in the event that a fair value of the yacht is not
available.)
Fair value of the yacht $6,000,000

Carrying value of the Sarah Mitcheltree 10,200,000
Impairment loss $ 4,200,000
Requirement 3:
DR Impairment loss $4,200,000

CR Yacht $4,200,000
Requirement 4:
11-23
Education.
The company might revise the asset’s estimated useful life or its salvage value,
depending on market conditions. However, it cannot reverse any part of the
impairment loss recorded in requirement 3.
Requirement 5:
Under U.S. GAAP, impairment losses cannot be reversed. Therefore, it makes
no difference what the recoverable amount rises to in the future.
11-24
Education.
P11-11. Determining asset impairment under IFRS (LO 11-5, LO 11-10)
Requirement 2:
The following impairment test indicates that Yachting in Paradise’s yacht is
impaired:
Book value:
= ($15,000,000 − $3,000,000) ÷ 15 = $800,000/year depreciation

= $800,000 x 6 years [20X1 through 20X6 inclusive] = $4.8 million
$15,000,000 − $4,800,000 = $10,200,000 book value in early 20X7
IFRS dictates than an asset should not be carried at more than its
recoverable value, defined as the higher of an asset’s fair value less costs
to sell and its value in use. The latter is defined as the present value of the
future cash flows expected to be derived from an asset.
Thus, the recoverable value of the Sarah Mitcheltree is the higher of its $6
million fair value and the $6.6 million present value of its future cash flows, or
$6.6 million.
The yacht is impaired since its recoverable value is below its carrying value.
An asset’s impairment is measured by reference to its recoverable value (see

requirement 2).
Recoverable value of the yacht $6,600,000

Impairment loss $ 3,600,000
Requirement 3:
DR Impairment loss $3,600,000

CR Yacht $3,600,000
Requirement 4:
Under IFRS, if the estimates used to determine an asset’s recoverable value
have changed, a previously recognized impairment loss shall be reversed, but
the reversal shall not yield a carrying amount in excess of the carrying amount
that would have been determined had such an impairment loss not been
recognized. If the loss in requirement 3 not been recorded, the book value of
the Sarah Mitcheltree would have been $8.6 million [$10.2 million – ($800,000
depreciation x 2 years)]. Book value at the time of recovery is determined as
follows:
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Education.
= ($6,600,000 − $0 salvage) ÷ 9 = $733,333/year depreciation
= $733,333 x 2 years [2017 through 2018 inclusive] = $1,466,666
= $6,600,000 − $1,466,666 = $5,133,334 book value in early 20X9
Recoverable value of the yacht $8,000,000

Reversal of impairment loss $ 2,866,666
DR Yacht $2,866,666
CR Reversal of impairment loss $2,866,666
Requirement 5:
See the answer in requirement 4, noting that the carrying value in early 20X9
after reversing any impairment loss cannot exceed $8.6 million. Thus, if the
recoverable amount were to be $10 million, the reversal of impairment loss
would be limited to $3,466,666 ($5,133,334 carrying value + $3,466,666 loss
recovery = $8.6 million).
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P11-12. Accounting for computer software costs (LO 11-4)
Requirement 1:
Until the technological feasibility of the product is proven, all costs are
expensed as R&D. After technological feasibility is proven, the costs are
supposed to be capitalized up to the point the product is made available for
sale. These capitalized costs are then amortized over the expected life of the
project. If any costs are incurred after the product has been made available for
sale, they are expensed.
Requirement 2:
This amount cannot be determined from the information given. While we can
determine the costs incurred after technological feasibility has been shown
(see Requirement 3), we cannot know how much IBM expended up to the
point that technological feasibility was reached on the various projects.
Requirement 3:
$2,419 + $11,276 = $13,695
Requirement 4:
($2,963 + $10,793) + $2,997 - X = ($2,419 + $11,276)
X = $3,058, where X is the gross amount of software-related costs that were

written off in Year 2. (The offsetting DR was to accumulated amortization.) So:
$10,793 - $3,058 + Y = $11,276
Y = $3,541, where Y is the credit to accumulated amortization. The offsetting
DR of $3,541 is the estimate of IBM’s amortization in Year 2.
Requirement 5:
Total capitalized software at the end of Year 2/software amortization for Year
2:
($2,419 + $11,276)/$3,058 = 4.48 (about 4-1/2 years).
Requirement 6:
Earnings can be managed by judicious selection of the point in time when
technological feasibility has been reached. For example, a firm that wants to
boost income in a given year would declare that technological feasibility has
been reached sooner than warranted so that costs could begin to be
capitalized rather than expensed. The situation is reversed for firms that want
to depress current year earnings.
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P11-13. Recognizing asset impairment (LO 11-5)
The $140 million accumulated depreciation is determined as follows (in

millions):
Cost $300
Less: Expected (
salvage value 60)
Cost to recover $240
Economic life ÷ 12
Depreciation per year $ 20
Years in use × 7
Accumulated
depreciation 140
Consequently, the book value is $160 million ($300 million Cost less $140
million Accumulated depreciation).
Requirement 1:
The asset is not impaired, and no loss needs to be recognized. The
undiscounted present value of the future cash flows from the Supersweet
patent are:
[($58.7 + 64.3 + 70.7 + 77.8 + 85.6) x 0.50] + $25.0 = $203.55
Since $203.55 is greater than the book value of the patent, no impairment of
the asset has occurred.
Requirement 2:
The asset is impaired, and a loss needs to be recognized. The undiscounted
present value of the future cash flows from the Supersweet patent are:
[($58.7 + 64.3 + 70.7 + 77.8 + 85.6) x 0.25] + $25.0 = $114.275
Since $114.275 is less than the book value of the patent of $160.0,
an impairment of the asset has occurred. The amount of the loss to recognize
is:
Current book value - current market value
$160.0 - $68.0 = $92.0 million

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Education.
The loss would be recognized in National Sweetener’s 20X7 income
statement, and the patent would be reported at $68.0 million in the firm’s 20X7
ending balance sheet.
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Education.
P11-14. Capitalizing interest (LO 11-2)
Requirement 1:
($80,000,000 x 0.13) + ($200,000,000 x 0.115) = $33,400,000.
Requirement 2:
($80,000,000 x 0.13) + ($70,000,000 x 0.115) = $18,450,000.
This is the avoidable interest. Note that $80,000,000 + $70,000,000 equals the
average balance in construction-in-progress.
This approach first uses the interest rate on the debt issued specifically for the
construction project. Alternatively, the company could use a weighted average
rate for all the expenditures. The weighted average rate would be 11.93%
($33,400,000 interest divided by $280,000,000 total debt). This approach
yields capitalized interest of $17,895,000 ($150,000,000 x 0.1193). A firm
would have to use one of the approaches consistently. We use $18,450,000 in
subsequent calculations.
Requirement 3:
Zero: Firms are not allowed to include the “implicit” cost of equity financing as
part of the cost of self-constructed assets. Thus, GAAP implicitly assigns a
zero cost to equity issued to help finance the construction.
Requirement 4:
The amount of capitalized interest will be added to the firm’s construction-in-
progress account.
Requirement 5:
$33,400,000 - 18,450,000 = $14,950,000.
Requirement 6:
The amount of capitalized interest will reduce future earnings over the useful
life of the facility, as it will be a component of the depreciation expense taken
each year of the asset’s useful life.
Requirement 7:
Interest coverage ratio with interest capitalization:
= $50,000,000/$14,950,000
= 3.34 times
Interest coverage ratio without interest capitalization:

= $50,000,000/$33,400,000
= 1.50 times
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Education.
The interest coverage ratio without the interest capitalization would be more
helpful to a creditor because it is based on the interest that the firm must
actually pay.
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P11-15. Accounting for internally developed patents versus purchased patents
(LO 11-3, LO 11-4)
Note to Instructor: Although the specific case relates internally developed

versus purchased patents, the case can be used to illustrate why firms in
different industries have different ratios, how an acquisition could change
ratios, and how capitalization versus expensing ultimately affects the balance
sheet and income statement.
Requirement 1:
Micro Systems Inc. must expense the $10,000,000 each year as R&D. Macro
Systems Inc. will capitalize $10,000,000 each year and amortize it over a 5-
year period.
Requirement 2:
Micro Systems Inc.
This firm’s profit margin increases each year as sales grow faster than the
firm’s expenses.
Micro Systems Inc. - Internally
developed
($ in thousands) 20X1 20X2 20X3 20X4 20X5
$290,00 $350,00 $400,00

Sales $ 200,000 $ 242,000 0 0 0
170,00 205,0 245, 265,
Operating expenses 140,000 0 00 000 000
10,00 10,0 10, 10,
R&D 10,000 0 00 000 000
Patent amortization
expense
62,00 75,0 95, 125,
Income before tax 50,000 0 00 000 000
13,02 15,7 19, 26,
Income taxes 21% 10,500 a 0 50 950 250
48,98 59,2 75, 98,
Net income 39,500 0 50 050 750
Profit margin 19.8% b 20.2% 20.4% 21.4% 24.7%
a
$10,500 income taxes = 21% tax rate x $50,000 income before tax.
b
19.8% profit margin = $39,500 net income ÷ $200,000 sales.
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Macro Systems Inc.
Macro Systems Inc. - purchased patents
Sales $ 200,000 $ 242,000 $ 290,000 $ 350,000 $ 400,000

Operating expenses 140,000 170,000 205,000 245,000 265,000
R&D
Patent amortization expense 2,000 4,000 6,000 8,000 10,000
Income before tax 58,000 68,000 79,000 97,000 125,000
Income taxes 21% 12,180 14,280 16,590 20,370 26,250
Net income 45,820 53,720 62,410 76,630 98,750
Profit margin 22.9% 22.2% 21.5% 21.9% 24.7%

Macro Systems Balance sheet
Patent 10,000 20,000 30,000 40,000 50,000
Accum. Amort. 2,000 6,000 d 12,000 20,000 30,000
Net 8,000 14,000 18,000 20,000 20,000
Depreciation by year of purchase

20X1 2,000 c 2,000 2,000 2,000 2,000
20X2 2,000 2,000 2,000 2,000
20X3 2,000 2,000 2,000
20X4 2,000 2,000
20X5 2,000
Total depreciation 2,000 4,000 6,000 8,000 10,000
c
Each expenditure of $10,000 is amortized over five years, resulting in $2,000 per year
of amortization for each purchase. At the end of five years, the asset is fully amortized.
d
$6,000=20X1 Accumulated amortization of $2,000 + 20X2 amortization expense of
$4,000.
Macro Systems’s profit margin falls over the first 3 years as the patent
amortization expense increases each year. In 20X4 and 20X5, it increases as
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the increase in sales is enough to offset the increase in operating expenses
and amortization expense. Note that Macro’s profit margin is higher than
Micro’s each year until 20X5 due to the capitalization and related amortization
of its patent acquisitions.
The key aspect of this analysis for the financial analyst is that while the two
firms were otherwise identical (i.e., same sales, operating expenses, and tax
rate), the fact that one firm performed its own R&D while the other purchased
it from other firms led to some important differences in their apparent
profitability. Once Macro’s amortization is equal to the annual expenditure,
Macro’s and Micro’s profit margins are identical.
Requirement 3:
As mentioned in requirement 2, the net income and profit margins of the firms
would converge to the same amount because Macro Systems Inc. would hit a
steady state of $10,000,000 in patent amortization each year which equals the
$10,000,000 spent on R&D by Micro Systems. Thus, the differences noted in
Requirement 2 become less important over time if R&D expenditures are
stable for the two firms.
However, Macro Systems will have $20,000 in net assets on its balance sheet
that Micro Systems will not have (see above). Consequently, after 20X5, ratios
that use assets or shareholders’ equity will be higher for Micro Systems than
for Macro Systems.
The analysis for Macro Systems also shows the general effects of expensing
versus capitalization. Eventually, the effects on net income are similar, but
balance sheet differences persist. Depending on the type of business, some
firms may look like Macro Systems, while other firms will look like Micro
Systems. This helps explain why balance sheet-based ratios differ across
industries. In addition, a firm that begins as a Micro Systems-type firm could
begin looking like a Macro Systems-type firm if it acquires other firms and
must recognize the fair value of the acquired assets on its balance sheet.
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P11-16. Determining earnings effects of changes in useful lives and salvage
values – SL (LO 11-7)
Requirement 1:
Original cost of buildings $4,694,000,000
Less: Salvage value (5% of costs) 234,700,000
Depreciable cost 4,459,300,000
Multiplied by (1 - .353) x .647
Undepreciated depreciable cost 2,885,167,100
Plus: Salvage value 234,700,000
Estimated book value of buildings $3,119,867,100
Requirement 2:
Revised depreciation schedule:
Book value after 12 years $3,119,867,100

Less: Salvage value (10% of Cost) 469,400,000
Amount to depreciate $2,650,467,100
Annual depreciation $94,659,539

($2,650,467,100/28*)
*Remaining useful life = 40 - 12 = 28
Increase in income before tax due to the changes:
Old depreciation expense:

Original cost of buildings $4,694,000,000
Less: salvage value (5% of cost) 234,700,000
Amount to depreciate $4,459,300,000
Annual depreciation
($4,459,300,000/34) $131,155,882
Revised depreciation expense: 94,659,539
Increase in income before tax $ 36,496,343
Increase in net income:

$36,496,343 x (1 - 0.21) = $ 28,832,111
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P11-17. Identifying straight-line versus accelerated depreciation ratio effects –
SL and SYD (LO 11-7, LO 11-8)
Requirement 1:
The solution under straight-line depreciation is:
SL Method 20X0 20X1 20X2 20X3

Sales $1,000.00 $1,250.00 $1,562.50
$1,953.13
Cost of goods sold1 600.00 811.67 860.04 912.04
Gross profit 400.00 438.33702.46 1,041.09
Operating expenses2 150.00 256.00 262.24 268.73
Income before tax 250.00 182.33440.22772.36
Income taxes 85.00 61.99 149.67 262.60
Net income $165.00 $120.34$290.55$509.76
Cost of machine $500.00

Cost of new computer $300.00
Average total assets $1,000.00 $1,200.00 $1,440.00

$1,728.00
Gross profit rate (rounded) 0.40 0.35 0.45 0.53
NOPAT margin (rounded) 0.17 0.10 0.19 0.26
Return on assets (rounded) 0.17 0.10 0.20 0.29
1
Total cost of goods sold.
a) Excluding the depreciation on
the new machine, the cost of goods
sold is expected to increase at a
rate of 7.5%. This amount is: $600.00 $645.00 $693.38 $745.38
b) The depreciation component is $500/3 166.67 166.66 166.66
Total cost of goods sold $811.67 $860.04 $912.04
2
Total operating expenses.
the new computer, operating expenses
are expected to increase at a
b) The depreciation component is $300/3 100.00 100.00 100.00
Total operating expenses $256.00 $262.24 $268.73
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Requirement 2:
The solution under sum-of-years’ digits is:
SOYD Method 20X0 20X1 20X2 20X3

Sales $1,000.00 $1,250.00 $1,562.50
$1,953.13
Cost of goods sold1 600.00 895.00 860.04 828.72
Gross profit 400.00 355.00 702.46 1,124.41
Operating expenses2 150.00 306.00 262.24 218.73
Income before tax 250.00 49.00 440.22 905.68
Income taxes 85.00 16.66 149.67 307.93
Net income $165.00 $32.34 $290.55 $597.75
Cost of new machine $500.00

Cost of new computer system $300.00
Average total assets $1,000.00 $1,200.00 $1,440.00

$1,728.00
Gross profit rate (rounded) 0.40 0.280.45 0.58
NOPAT margin (rounded) 0.17 0.030.19 0.31
Return on assets (rounded) 0.17 0.030.20 0.35
1
Total cost of goods sold.
a) Exluding the depreciation on
the new machine, the cost of goods
sold is expected to increase at a
b) The depreciation component is: 250.00 166.66 83.34
Total cost of goods sold $895.00 $860.04 $828.72
2
Total operating expenses.
the new computer, operating expenses
are expected to increase at a
b) The depreciation component is: 150.00 100.00 50.00
Total operating expenses $306.00 $262.24 $218.73
Requirement 3:
The ratios are shown in the schedules in Requirements 1 and 2. With regard to
the differences between the ratios of the two firms, the following points are
worth noting. While the firms are otherwise identical except for the choice of
depreciation method (i.e., same sales, cost of goods sold, operating expenses,
income tax rate, growth rates in various income statement items), there are
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Education.
some important differences that arise in the ratios due to the choice of
depreciation method.
a) In 20X1, SL method ratios significantly exceed those of the SOYD method.

For example, a gross profit rate of 35% versus 28%, a NOPAT margin of
10% versus 3%, and a return on asset ratio of 10.0% versus 3%. This is, of
course, due to the greater amount of depreciation expense reported by the
SOYD method relative to the SL method in 20X1.
b) In 20X2, all ratios are the same because the depreciation expense under
both methods is the same.
c) In 20X3, SOYD method ratios exceed those of the SL method. For example,
a gross profit rate of 58% versus 53%, a NOPAT margin of 31% versus 26%,
and a return on asset ratio of 35% versus 29%. This is, of course, due to the
greater amount of depreciation expense reported by the SL method relative
to the SOYD method in 20X3.
d) It is also worth noting that across all years both methods report identical
totals for their income statement items (e.g., cost of goods sold, gross profit,
etc.). This, of course, is due to the fact that the amount of depreciation
recorded under each method is the same over the life of the asset; all that
differs between the two methods is the year-to-year pattern in the amount of
depreciation recorded.
e) In summary, the behavior of the ratios under the two methods illustrates that
depreciation policy choice can introduce “artificial” differences in the
apparent profitability of two otherwise identical firms. This means that
analysts should pay attention to the depreciation policy choices of firms they
intend to compare.
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P11-18. Making asset age and intercompany comparisons (LO 11-3)
Requirement 1:
ROA for Gardenia Co. (000s omitted):
Jan. 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31

20X1 20X1 20X2 20X3 20X4 20X5
Asset net book value $20,000 $18,000 $16,000 $14,000 $12,000 $10,000
Net operating cash

flow, increasing
2%/year $3,000 $3,060 $3,121 $3,183 $3,247
Depreciation exp. 2,000 2,000 2,000 2,000 2,000
Pretax profit $1,000 $1,060 $1,121 $1,183 $1,247
ROA on beginning 5% 5.9% 7% 8.5% 10.4%

of year assets
Average age of
assets 1 year 2 years 3 years 4 years 5 years
11-40
Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Requirement 2:
ROA for Lantana Co. (000s omitted):
Jan. 1 Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31

20X1 20X1 20X2 20X3 20X4 20X5
Asset net book value $20,000 $20,080* $20,234 $20,455 $20,736 $21,071
Net operating cash

flow, increasing
2%/year $5,000 $5,100 $5,202 $5,306 $5,412
Depreciation exp. 4,000 4,008 4,024 4,049 4,082
Pretax profit $1,000 $1,092 $1,178 $1,257 $1,330
ROA on beginning 5% 5.4% 5.8% 6.1% 6.4%

of year assets
Average age of
assets 5 years 5 years 5 years 5 years 5 years
11-41
Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
20X1 20X2 20X3 20X4 20X5
Beginning of the
year gross assets1 $40,000 $40,080 $40,242 $40,487 $40,817
Less: retired ($4,000) ($4,000) ($4,000) ($4,000) ($4,000)
Add: new assets 4,080 4,162 4,245 4,330 4,417
End of year gross $40,080 $40,242 $40,487 $40,817 $41,234

assets
Depreciation expense $4,000 $4,008 $4,024 $4,049 $4,082

(Beginning of year
x 10%)
1
Assets are, on average, 5 years old, with a 10-year life = ½ depreciated. Therefore,
$20,000,000 net asset base x 2 = $40,000,000 gross asset base.
*Computed as: Beginning net book value ($20,000,000) + capital expenditures ($4,080,000) –
depreciation expense ($4,000,000). All other years computed similarly.
Requirement 3:
Gardenia’s rapidly increasing ROA gives the appearance of significant year-
to-year improvement. But this is illusory because the ROA increase is caused
primarily by the increasing average age of its asset base. This factor would
alone cause ROA to increase even in the absence of inflation. But the upward
drift is exacerbated by the 2% annual increase in net operating cash flow.
Lantana’s much smaller upward drift in ROA is attributable to the stable

average asset age that results from its continual replacement of 10% of its
assets. Lantana’s ROA drifts slightly upward.
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Education.
P11-19. Accounting for asset retirement obligations (LO 11-6)
Requirement 1:
GAAP requires companies to recognize an asset retirement obligation (ARO)
when a reasonable estimate of its fair value can be made. These legal
obligations arise when a company builds or buys an asset that requires
mandatory expenditures at the end of the asset’s useful life to protect public
welfare or improve safety. For example, dismantling an offshore oil platform
requires expenditures to protect and restore the marine environment.
Coyote Co. can estimate the fair value of this obligation as the present value
of the estimated future cash outflows.
Payment $15,000,000
x PV factor, 5 periods, at 10% .62092
= Present value of the ARO $ 9,313,800
Journal entry:
01/01/Year 1
DR Asset retirement cost--Landfill $9,313,800
CR Asset retirement obligation $9,313,800
Amortization table:
(a) (b) (c)
Present Value Present Value
ARO Accretion ARO
Year At 1/1 Expense At 12/31
1 $ 9,313,800 $ 931,380 $10,245,180
2 10,245,180 1,024,518 11,269,698
3 11,269,698 1,126,970 12,396,668
4 12,396,668 1,239,667 13,636,335
5 13,636,335 1,363,634 14,999,969*
*rounding error of $31
Requirement 2:
The costs associated with the decommissioning of the power plant will be
shown on the income statement as both:
 Increased depreciation expense each period as a result of recording and
depreciating the asset retirement cost asset as shown in requirement 1, and
 Accretion expense each period as shown in column (b) of the amortization
table in requirement 1.
The entry to record the interest (for example, in year 1) is:
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DR Accretion expense $931,380
CR Asset retirement obligation $931,380
The $15,000,000 total decontamination cost is shown as part of the expense

of operating the power plant and is matched with the revenue generated by
the plant over its productive life. Prior to the issuance of pre-Codification
SFAS No. 143, companies would often ignore these costs until they were
incurred at the end of the asset’s life, thereby overstating operating income.
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Education.
P11-20. Accounting for assets held for sale (LO 11-6)
Requirement 1:
Carrying value at 12/31/20X1:
Historical cost $12,000,000

Less: Accumulated depreciation (5,500,000)
Carrying value $ 6,500,000
When assets are held for sale, they are reported at the lower of carrying value
or fair value less costs to sell. The fair value less costs to sell of the railroad
assets is:
Sales price $5,900,000

Less: Broker’s fee (360,000)
Legal fee (246,000)
Closing costs (67,000)
Fair value less costs to sell $5,227,000
Since management has committed to a plan, has identified a potential buyer,

and is anticipating a sale within the year, the railroad assets should be
reported at fair value less costs to sell. This requires Prescott Co. to write
down the assets from their carrying value of $6,500,000 to their fair value less
costs to sell of $5,227,000 and record an impairment loss of $1,273,000*. This
loss will be reported on the income statement under “Discontinued
operations”.
*(This is $6,500,000 - $5,227,000)
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Requirement 2:
Prescott’s income statement for the year ended December 31, 20X1 should
report discontinued operations for the railroad component after income from
continuing operations and before extraordinary items.
Prescott Co.
Partial Income Statement
For the Year Ending December 31, 20X1
Income from continuing operations $7,875,000*
Discontinued operations (see Note xx)
Loss from operations of
discontinued railroad component
(Including $1,273,000 impairment
loss) (1,748,000)+
Net income $6,127,000
*(This is net income of $7,400,000 plus the loss of $475,000 added back
on the railroad component)
+
(This is the loss on the railroad component of $475,000 plus the
impairment loss of $1,273,000)
Requirement 3:
Operating margin ROA
With DCO treatment
$7,875,000 $7,875,000
$18,200,000* = 43.3% $88,000,000+ = 8.9%
Without DCO treatment

$7,400,000 $7,400,000
$20,000,000 = 37% $94,500,000 = 7.8%
*(This is $20,000,000 – $1,800,000)

+(This is $94,500,000 – $6,500,000)
If the disposal does not qualify as a discontinued operation, Prescott Co.

would continue to report the results for the railroad component as part of
“Income from continuing operations.” This might provide financial statement
users with a misleading starting point for predictions and encourage them to
form unreasonable expectations about the company’s future performance.
Separate reporting of discontinued operations helps financial statement

readers make meaningful comparisons of year-to-year results for income from
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Education.
continuing operations. For all prior years presented for comparative purposes,
Prescott Co. must break out the results of operations of the railroad
component as if it were a discontinued operation. That is, if income results for
the year ending December 31, 20X0 are reported with results for 20X1 for
comparative purposes, Prescott Co. will report the railroad component as if it
were a discontinued segment when presenting the 20X0 results. This allows
financial statement readers to assess how well management manages the
ongoing operations year-to-year.
Requirement 4:
During 20X2 the assets held for sale will not be depreciated. The assets will
continue to be valued at the lower of carrying value or fair value less costs to
sell. Any losses previously recorded may be recovered—but not in excess of
the cumulative loss previously recognized (FASB ASC 360-10-35-40).
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Education.
P11-21. Evaluating approaches to long-lived asset valuation (LO 11-1)
Requirement 1:
Expected benefit approaches focus on the estimated value of long-term
assets in an output market, that is, a market where the assets could be sold.
This approach assigns a value to an asset based on the expected future cash
flows the asset is capable of generating. One valuation measure under this
approach is the discounted present value of the future cash flows the asset is
expected to generate. For example, a Boeing 777 jet owned by United Airlines
might be valued on the basis of the net operating cash flows (i.e., passenger
revenues less applicable costs) it is expected to generate over its useful life.
Another valuation measure under this approach is what the asset would bring
if it were sold in the marketplace. In this case, the Boeing 777 would be valued
at its net realizable value. Problems that arise in implementing the discounted
present value approach include determining the appropriate discount rate as
well as estimating the future net operating cash flows that the asset will
generate. A problem that arises under the net realizable value approach is
that not all assets have readily available quoted market prices.
Economic sacrifice approaches focus on an asset’s cost in an input market—a

market where the asset could be acquired. The most obvious example of this
approach is an asset’s historical cost, which is what the firm paid for the asset
when it was originally acquired. The main advantage of this approach is that
an asset’s historical cost is easy to measure, is objective, and is verifiable.
Historical cost is the dominant approach underlying current GAAP. A second

example of an economic sacrifice approach is current replacement cost. This
is the amount that would be required to purchase/replace the asset today with
an “identical” or “similar” asset. A problem that arises under this approach is
that the current replacement cost of existing assets may be difficult to obtain
for some assets.
Requirement 2:
From the perspective of a financial analyst, the answer to the question is yes.
Since the primary input into financial analysis is information about a firm,
analysts would like to have these other valuations in addition to historical cost.
After all, if they feel that any of the additional valuations are not as reliable as
historical cost in a given setting, they can always choose to ignore them. But
having these data would make trend analyses, cross-sectional comparisons,
and basic ratio analysis more meaningful since the distortions of historical cost
accounting would be reduced.
11-48
Education.
Requirement 3:
The primary benefit is a more relevant valuation of the company’s assets, and,
thus, a more relevant valuation of the entire company (i.e., its common stock).
The primary cost, which most managers would probably argue exceeds the
expected benefit, is that many of these numbers would need to be based on
estimates about the future conditions of the firm and appropriate discount
rates. Many managers believe that the necessity of these estimates will
introduce enough measurement error into these voluntary disclosures so as to
make them less than perfect measures of true underlying asset values and
diminish their usefulness to outside parties.
11-49
Education.
P11-22. Weakness of the Straight-line Depreciation Method (LO 11-1, LO 11-7)
Requirement 1:
a. Annual depreciation expense = (Cost – salvage) ÷ life
$3,962 = ($15,849 − $0) ÷ 4
End of Depreciation Accumulated Book

Year Expense Depreciation Value
20X1 3,962 3,962 11,887
20X2 3,962 7,924 7,925
20X3 3,962 11,886 3,963
20X4 3,963 15,849 -
b. If the company were to record straight-line depreciation, its four years’ income statements
would appear as follows:
20X1 20X2 20X3 20X4

$ $ $
Revenue 5,000 5,000 5,000 $ 5,000
3,96 3,96 3,96
Depreciation expense 2 2 2 3,963
$ $ $
Net income (A) 1,038 1,038 1,038 $ 1,037
$ $ $
Initial investment (B) 15,849 11,887 7,925 $ 3,963
Less: depreciation 3,96 3,96 3,96
expense 2 2 2 3,963
$ $ $
Ending investment balance 11,887 7,925 3,963 $ -
c.
Return on investment (A ÷ B) 6.5% 8.7% 13.1% 26.2%
Requirement 2:
a.
Under the present value method of depreciation, annual depreciation expense is the
difference between the present value of future cash flows at the beginning of year and end of
year.
Beginning
of year PV
Annual of Future Depreciation Accumulated
Yea
r cash flow cash flows expense Depreciation Book Value
1 5,000 15,849 3,415 3,415 12,434

2 12,43 3,756 7,171 8,678
11-50
Education.
5,000 4
3 5,000 8,678 4,133 11,304 4,545
4 5,000 4,545 4,545 15,849 -
11-51
Education.
b.
20X1 20X2 20X3 20X4
$
Revenue 5,000 $ 5,000 $ 5,000 $ 5,000
3,41
Depreciation expense 5 3,756 4,133 4,545
$
Net income (A) 1,585 $ 1,244 $ 867 $ 455
$
Initial investment (B) 15,849 $ 12,434 $ 8,678 $ 4,545
Less: depreciation 3,41
expense 5 3,756 4,133 4,545
$
Ending investment balance 12,434 $ 8,678 $ 4,545 $ 0
c.
Return on investment (A ÷ B) 10% 10% 10% 10%
Requirement 3:
Clearly, the rising annual return on investment under straight-line is an illusion,

created by the use of an arbitrary method of depreciation. In this example, with
straight-line depreciation, a constant numerator (Net income) is divided by a
declining denominator (Initial investment) to produce a rising annual return on
investment, which is a counter-intuitive result. Why should the annual return on
investment be rising when the actual cash inflow each year was precisely as
anticipated? Each year, in these circumstances, the return should be 10%.
On the other hand, the present value method yields an annual return on
investment of 10% in the income statement so long as the actual cash flows
coincide with the anticipated cash flows. If the actual cash flows were to
exceed, or fall short of, the anticipated cash flows, the annual return on
investment would be correspondingly higher or lower. The use of this method
enables a reader of the income statement to determine whether, and to what
extent, the company achieved its required 10% return on investment. Another
way of looking at the “present value method” is that the depreciation expense
each year represents the implicit depreciation when one calculates the present
value of the stream of annual cash flows. This present value becomes the cost
the company is willing to pay for the asset in order to achieve the required
return on investment. Thus, a strong case can be made that the present value
depreciation method, when compared to the straight-line method, provides
more useful information.
11-52
Education.
Requirement 4:
The “present value method” is generally not an acceptable method in U.S.

financial reporting, primarily because it is too subjective. Estimates of annual
future cash flows—especially those expected to occur many years in the future
—are highly speculative. So while this approach certainly seems to fit the
general depreciation criteria of a method that is both “systematic and rational,” it
falls short when it comes to verifiability and objectivity. It may, however, be
used by companies for internal reporting purposes, especially when one seeks
to evaluate the performance of divisions and subsidiaries.
A form of this method is used for amortizing the operating lease right-of-use
asset. In this case, the cash flow amounts and discount rate are known. See
Chapter 13 for more information on leases.
11-53
Education.
P11-23. IFRS impairment and revaluation (LO 11-10)
Requirement 1: Cost model
12/31/20X0:
No entry
12/31/20X1:
DR Impairment loss: land €250,000
CR Land €250,000
12/31/20X2:
DR Land €100,000
CR Impairment loss: land €100,000
Impairment loss reversals should be disclosed separately from new impairment

losses.
Requirement 2: Revaluation model
12/31/20X0:
DR Land €150,000
CR Revaluation surplus €150,000
12/31/20X1:
DR Revaluation surplus €150,000
DR Impairment loss: land €250,000
CR Land €400,000
12/31/20X2:
DR Land €100,000
CR Impairment loss: land €100,000
11-54
Education.
P11-24. IFRS impairment and revaluation (LO 11-10)
Requirement 1: Cost model
12/31/20X0:
DR Depreciation expense €35,000*
CR Accumulated depreciation: hotel €35,000
*2,100,000/30 years x ½ year
12/31/20X1:
DR Depreciation expense €70,000**
**(2,100,000 – 35,000)/29.5 years

New carrying value = 2,100,000 – 35,000 – 70,000 = 1,995,000
Need to impair to recoverable amount of 1,400,000
DR Impairment Loss €595,000

12/31/20X2:
DR Depreciation expense €49,123***
***1,400,000/28.5 years
New carrying value = 1,400,000 – 49,123 = 1,350,877
Need to reverse impairment (limited to 595,000 of prior impairment write-downs)
DR Accumulated depreciation: hotel €349,123
CR Impairment reversal €349,123
11-55
Education.
Requirement 2: Revaluation model
12/31/2016:
DR Depreciation expense €35,000*
*2,100,000/30 years x ½ year. This catches up depreciation before the revaluation.

DR Hotel €100,000
CR Revaluation surplus €135,000
12/31/2017:
DR Depreciation expense €74,576**
**(2,200,000)/29.5 years
DR Revaluation surplus €4,576***

CR Retained earnings €4,576
***(135,000)/29.5 years
New revaluation surplus balance = 135,000 – 4,576 = 130,424
Need to impair to recoverable amount of 1,400,000
DR Revaluation surplus €130,424
DR Impairment Loss €595,000
12/31/2018:
DR Depreciation expense €49,123***
***1,400,000/28.5 years
Need to reverse impairment (limited to 595,000 of prior impairment write-downs)
CR Impairment reversal €349,123
11-56
Education.
Financial Reporting and Analysis (8th Ed.)
Chapter 11 Solution
Cases
Cases
C11-1. Target Corporation and Wal-Mart Stores, Inc. (Walmart): Identifying
depreciation differences and performing financial statement analysis (LO
11-8)
Requirement 1:
The estimated average useful life of Target’s assets is:
Average useful life = average gross PP&E (excluding land and construction in
progress)/depreciation expense
= ([($26,614 + $5,346 + 2,553) + ($25,984 + $5,199 + 2,395)]/2)/$2,129
= ([$34,513 + 33,578]/2)/$2,129
= $34,045.5/$2,129
= 16.0 years
The estimated average useful life of Walmart’s assets is:
Average useful life = average gross PP&E (excluding land)/depreciation

expense
= ([($177,395 - $26,261) + ($173,089 - $26,184)]/2)/$9,100
= ([$151,134 + $146,905)]/2)/$9,100
= $149,019.5/$9,100
= 16.4 years
Requirement 2:
Walmart’s revised, estimated depreciation expense would be:
= Average gross PP&E (excluding land)/Target life
= $149,019.5/16.0
= $9,314
11-57
Education.
Walmart’s revised, estimated depreciation expense is higher because of the
shorter average useful life of Target’s assets.
Walmart’s income before taxes would decrease by $9,314 – 9,100, or $214

(i.e., the increase in the depreciation expense that would have been recorded).
The revised amount of income before tax of $24,799 - 214 = 24,585 might be
more valid in ratio and trend comparisons if the difference in average useful
lives is not due to real underlying economic differences in the firms’
circumstances.
Walmart’s Income from continuing operations of $16,814 for the year ended
January 31, 2015 would decrease by $139.1 [$214 * (1-0.35)] to $16,674.9,
which, again, might be more valid when comparing Walmart’s and Target’s
ratios if the useful lives’ differences do not reflect differences in underlying
economic conditions.
Requirement 3:
Target’s revised, estimated depreciation expense for the year would be:
= Average gross PP&E (excluding land)/Walmart life
= ($26,614 + $5,346 + 2,553)/16.4
= $34,045.5/16.4
= $2,075.9
Target’s revised, estimated depreciation expense is lower because of the

longer average useful life of Walmart’s assets.
The following calculations are simply the flip side of those in Requirement 2.
Target’s earnings before income taxes would increase by $2,129 - $2,075.9, or

$53.1 (i.e., the decrease in the depreciation expense that would have been
recorded). The revised amount of income before tax of $3,653 + $53.1 =
$3,706.1 might be more valid for ratio and trend comparisons. Again, this
answer presumes that the differences in useful lives do not reflect different
underlying economic conditions.
Target’s net earnings from continuing operations of $2,449 would increase by

$34.5 [$53.1*(1-0.35)] to $2,483.5 which might be more appropriate for ratio
comparisons.
11-58
Education.
Requirement 4:
The comparability of the financial statements of firms in the same industry,

hence, comparisons involving their financial ratios, can be hindered by
differences in depreciation policy. The analysis above provides a means to
control for differences emanating from differences in useful lives for assets that
are expected to be similar in most respects. For fiscal 2014, the assumed lives
for both companies appear to be similar.
Requirement 5:
Some factors that affect the reliability and accuracy of the adjustments made
above include:
a) The analysis assumes that the firms have similar proportions of the various
assets included in the overall plant and equipment category.
b) The analysis above assumes that the salvage values used by the firms are
reasonably similar.
c) The extent to which a firm may use accelerated depreciation methods for a
portion of its long-term assets.
d) The extent to which the different useful life choices are, in fact, driven by
differences in the underlying economic fundamentals of the firm.
e) The amount of amortization (included in “Depreciation and amortization”
without separate disclosure) that relates to assets other than property and
equipment.
11-59
Education.
C11-2. AT&T Inc: Analyzing financial statement effects of capitalized interest
(LO 11-2)
Requirement 1:
DR Construction in progress $493 million
CR Interest expense $493 million
Requirement 2:
2018 2017 2016
Interest expense, net $ 7,957 $ 6,300 $ 4,910
Capitalized interest 493 903 892
Interest expense before
capitalization $ 8,450 $ 7,203 $ 5,802
Percent capitalized 5.8% 12.5% 15.4%
Requirement 3:
Income before income taxes: $24,873 (as reported)
Capitalized interest -493
Revised income before income taxes $24,380 (without capitalization)
Percentage decline = (-$493)/$24,873

= -1.98%
Requirement 4:
Net income $19,953.0
(as reported)
Capitalized interest (after-tax) -395.4 [$493 x (1-0.198*)]
Revised net income $19,557.6
Percentage decline = (-$395.4)/$19,953.0)

= -1.98%
*The 2018 effective tax rate of 19.8% is computed as 1 – (Net income of

$19,953 ÷ Income before income taxes of $24,873).
Requirement 5:
The capitalized interest will reduce future years’ reported earnings—in
comparison to earnings without capitalization—because it will enter the income
statement as part of the depreciation expense or cost of goods sold related to
the associated assets.
11-60
Education.
C11-3. Diamond Offshore Drilling, Inc.: Analyzing financial statement effects of
capitalized interest (LO 11-2)
Requirement 1:
DR Construction in progress $16,308,000
CR Interest expense $16,308,000
Requirement 2:
Pretax income – increase
Cash from operations – increase
Cash from investing activities – decrease
Assuming that the interest was actually paid, the reduction in interest expense
increases cash from operations but decreases cash from investing activities.
The $16,308,000 would be part of capital expenditures.
Requirement 3:
Because the $16,308,000 becomes part of Property and equipment once it is
put into production, it will be depreciated in subsequent years, thereby
decreasing pretax income.
Depreciation is a non-cash expense and will not affect cash from operations. If
the indirect method is used, the depreciation would be added to net income.
Investing activities would not be affected by the depreciation expense.
Requirement 4:
The price of oil fell from $110.00 at the end of 2013 to $37.00 by the end of
2015. The decline in oil prices made it unprofitable to explore for oil.
Consequently, DOD would have curtailed its new construction of drilling rigs
and equipment, which would have reduced the amount of avoidable interest.
11-61
Education.
C11-4. Diamond Offshore Drilling, Inc.: Analyzing financial statement effects of
asset impairment (LO 11-5)
Requirement 1:
The note states that the decline in oil prices led to reductions in customer
capital spending and contract cancellations. Additionally, drillers have to follow
stricter regulations when drilling in the Gulf of Mexico.
Requirement 2:
DR Loss on impairment of assets $860,441,000
CR Drilling rigs and equipment $860,441,000
Requirement 3:
Effect on Operating income:
Loss (860,441)
Operating income before the loss = 860,441 + (294,074)
(860,441)
=
860,441 + (294,074)
(860,441)
=
566,367
= -152%
Requirement 4:
The impairment loss does not affect cash from operating activities. If the indirect
method is used, the loss would be added back to the net loss. Managers are
often fond of saying that they only need to be concerned about items that affect
cash flows and that the loss only affects accounting income. However, the loss
indicates that revenues and cash from operating activities probably will be lower
in subsequent years because of reduced demand for DOD’s services.
Impairment losses often precede additional financial weakness. The
significantly large impairment loss (152% of operating income) indicates that
DOD may have cash flow problems for several years. During 2015, numerous
firms in the oil and gas industry declared bankruptcy.
11-62
Education.
C11-5. Royal Dutch Shell, plc: Identifying differences and similarities between
IFRS and GAAP (LO 11-10)
Similarities
1. Royal Dutch Shell uses depreciation methods that are allowed under U.S.
GAAP.
2. The company reviews its long-lived assets for impairment and reduces the
carrying value when appropriate.
3. Although the question asks about Property, plant, and equipment, the
instructor may also want to mention differences related to intangible assets.
1. Other intangibles are being amortized over their useful lives.
Presumably, there are no indefinite-lived intangibles given that
intangibles other than Goodwill are being amortized over 40 years or
less.
2. Goodwill is not amortized.
Differences
1. The test for impairment and the subsequent write-down are different from
U.S. GAAP. Shell reduces the carrying amount to the recoverable amount,
which is “the higher of fair value less costs to sell and value-in-use.” Value-
in-use equals the “estimated risk-adjusted discounted cash flows.” The
recoverable amount also is used for the impairment test under IFRS. Under
U.S. GAAP, the impairment test would be based on undiscounted cash
flows, and the write-down would be based on fair value, which is
sometimes estimated by discounting expected cash flows.
2. IFRS allows firms to reverse impairment losses. This is evident from the
impairment loss schedule. In 2014, Royal Dutch Shell had new impairment
losses of $6,983 million, but it also reversed $344 million of previously
recognized impairment losses. Because of a different impairment test and
basis for write-down, it is difficult to determine what amount of impairment
losses would have been recognized under U.S. GAAP. The $344 million
reversal would not be allowed under U.S. GAAP. Note the magnitude of the
2015 impairment loss in relation to Shell’s pretax income. The loss is 4.4
times the amount of pretax income ($9,010 million/$2,047 million). The low
2015 pretax income and the large impairment charges related to the falling
price of oil.
11-63
Education.
C11-6. Marston’s PLC: Identifying differences and similarities between IFRS and
GAAP (LO 11-10)
Similarities
1. Marston’s uses the straight-line method to depreciate the cost of the

assets, less salvage value, over their useful lives. This approach is also
used under U.S. GAAP.
2. Labor and interest costs are capitalized for self-constructed assets.
3. Land is not depreciated.
4. The company reviews its long-lived assets for impairment and reduces the
carrying value when appropriate.
Differences
1. IFRS allows long-lived tangible assets to be valued under the depreciated

cost model or a revaluation model. Marston’s revalues its properties on a
regular basis so that the carrying value “does not differ significantly from its
fair value.” When the assets are revalued upwards, the Revaluation reserve
within shareholders’ equity also is increased. When downward adjustments
are necessary, the assets are reviewed for impairment. Impairment losses
first reduce prior Revaluation reserves related to the assets, and additional
losses are recognized on the income statement. Only the depreciated cost
model is used under U.S. GAAP, and upward revaluations are not allowed.
2. The test for impairment and the subsequent write-down are different from
U.S. GAAP. Marston’s states that it recognizes an impairment loss when
the carrying value is less than the “recoverable amount,” which is “the
higher of value in use and fair market value less costs to sell.” Under U.S.
GAAP, the impairment test would be based on undiscounted cash flows,
and the write-down would be based on fair value, which is sometimes
estimated by discounting expected cash flows.
3. IFRS allows firms to reverse impairment losses. Marston’s states that a
loss may be reversed if the recoverable amount increases, but the new
asset value cannot exceed the carrying value that would have occurred
without the original impairment. Such reversals would not be allowed under
U.S. GAAP.
11-64
Education.

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Financial Reporting and Analysis (8th Ed.

Phoenix may capitalize the following costs to the Machine account:

E11-2. Determining depreciation expense—multiple methods (LO 11-7)

Major improvement to the plumbing $109,000

GAAP requires a company to capitalize expenditures that extend an asset’s

Historical cost $970,000

E11-5. Determining depreciation base – straight-line depreciation (LO 11-2, LO

$20,000/15 years = $1,333

Depreciation expense for 20X1 is $1,333.

Entry by Reading Phillies:

First, we must find the total cost of the machine.

Purchase price $65,000

Now we can find depreciation expense for 20X0 and 20X1:

Next, we need to determine the depreciation base of the machine in January

Depreciation base, January 1, 20X0 $62,800

DR Plant assets $41,698.70

E11-9. Determining retirement obligation (LO 11-6)

Purchase price of land $20,000,000

Depletion rate = (book value – salvage value) ÷ recoverable units

E11-10. Capitalizing interest (LO 11-2)

The avoidable interest during 20X1 is:

Cost incurred evenly over the year $2,000,000

DR Building (capitalized interest) $60,000

E11-12. Analyzing changes in asset account balances – straight-line (LO 11-3,

To determine the amount debited in 20X1, we reconstruct the accumulated

$370,000 + $55,000 - X = $400,000

Weir must have debited $25,000 to accumulated depreciation during 20X1

Line II corresponds to the sum-of-the-years’-digits method, and Line III

E11-14. Amortizing intangibles (LO 11-4)

First, determine the book value of the trademark at 1/1/20X4:

December 31, 20X0 20X1 20X2 20X3

$300,000 + $60,000 = $360,000

$360,000/12 years = $30,000

December 31, 20X1 20X2 20X3 20X4

DR Loss on impairment $54,000

The total charge to income in 20X4 is $63,000, i.e., $54,000 + $9,000.

E11-16. Accounting for R&D cost (LO 11-4)

R&D services performed by Key Corp. $150,000

E11-17. Accounting for R&D cost (LO 11-4)

Ball should expense $1,380,000 as research and development for 20X1.

E11-18. Accounting for software development costs (LO 11-4)

E11-19. Determining depletion expense with asset retirement obligation – units-

To determine the depletion base, we need to add together the costs

Purchase price of mine $2,640,000

Depletion base = $2,880,000 = $2.40 per unit

60,000 tons of ore removed x $2.40 per ton = $144,000

Vorst should report $144,000 as depletion expense for 20X1.

The other costs would have been incurred regardless of

Total cost − Salvage value =

Requirement 2 – Double-declining balance:

Requirement 4 – Units of production:

Total cost - Salvage value $ 864,000 - $ 144,000

= $0.40 per unit

Depreciation = depreciation cost per unit x number of units actually produced

FMV of land/FMV of land and building

Cost of land = $15,000,000 x .36 = $5,400,000

FMV of building/FMV of land and building

Cost of building = ($15,000,000 x .64) + cost of modifications to building

The other costs would have been incurred regardless of whether